CEZ (Hold, TP CZK923): Falling electricity prices

Investment case: We issue a new Hold recommendation on CEZ shares with an updated price target of CZK 923 (previous recommendation and price target were Buy and CZK1,034 as of November 7, 2023).

Electricity prices have stabilized around EUR90/MWh after record highs in the last two years. The price will continue to fall in the coming years. Special taxes had a significant impact on CEZ's results. The special windfall profits tax is still in force in 2024 and 2025. In addition, the standard corporate tax rate has increased from 19% to 21% as of this year. This results in a literally extreme effective tax rate (63% for 2023). CEZ has a very low emission intensity due to its high share of emission-free generation, especially nuclear power plants. Therefore, a high allowance price looks positive for CEZ.

CEZ has a solid dividend policy. The current one provides for distribution of 60-80% of adjusted net profit to shareholders. The dividend for 2023-2025 will be significantly influenced by the WFT. This year, CEZ paid out CZK52, which corresponds to a gross yield of +5.6%. The payout ratio was at the upper limit of 80%. Unlike last year, the Ministry of Finance, which exercises shareholder rights on behalf of the state (70% stake), did not propose to distribute the entire net profit. We estimate that CEZ will again propose a payout ratio of 80% next year. This would result in a dividend of CZK45. However, if the ministry were to propose a full payout, for example due to the large state budget deficit, it would mean CZK56 per share. This is our bull-case scenario, but given the validity of the WFT, we do not give it much probability.

We use a DCF (Discounted Cash Flow) model to value CEZ shares. We set the Fair Value of the stock at CZK923. This implies a growth potential of only +1.8%. The total return is +6.7%. We value CEZ at 6.0x EV/EBITDA, a discount to the Western European utility median of 7.2x. Moreover, CEZ offers investors a decent dividend yield of +5.0%.

Main risks: This time we will divide the risks into two categories. The first group includes risks related to the Company's operations. The most important risks in this category are the price of commodities (electricity and emission allowances) and the availability of generation resources, mainly nuclear power plants, which offer the highest margins. The second group is political risks. In particular, we refer to special taxes or regulations. The WFT is still in force for 2024 and 2025.

Author: Bohumil Trampota